Last week saw Facebook release the white paper officially announcing its much touted cryptocurrency, Libra.
The idea is as follows: consumers trade-in their local fiat currency in return for Libra. Libra then acts as a medium of exchange with which consumers can use to purchase goods or services online (Uber, Visa and eBay are three of 28 launch-backers, for example), or send to anyone around the world using platforms such as WhatsApp. Transactions are recorded on a blockchain and Libra can be traded back, fee-free, into local fiat currency at any time.
Libra is backed by real assets (the "Libra Reserve"), notionally ensuring price stability and fx predictability. It is not, however pegged to any particular currency.
Crypto-purists have observed that Libra ticks none of the classic cryptocurrency boxes. They argue that the processing and approval of transactions by the "Libra Association" (formed by Libra's backers) means that Libra does not possess the decentralisation and freedom from an intermediary that are cornerstone features of typical cryptocurrencies.
Nevertheless, Facebook's user base will probably ensure an adoption of Libra the sort of which most nascent cryptocurrencies can only dream of. But far from being a new direction in the crypto-space, Libra is broadly reflective of a wider move towards the creation of asset backed tokens - or stablecoins - as they have become known.
Stablecoins are the fastest growing crypto asset class. They are designed to be digital assets recorded on a blockchain which possess none of the volatility of typical cryptocurrencies. Rather, they aim to reflect or be pegged to an underlying conventional asset or currency, such as the US Dollar.
It might be said that the creation of stablecoins is a symptom of limitations in both conventional financial systems and cryptocurrencies. Mainstream adoption of cryptocurrencies remains limited, and issues surrounding scalability and regulation, as well as volatility, remain. Simultaneously, for many people around the world transferring fiat currency remains slow, bureaucratic, and expensive.
Stablecoins try to bridge the gap between the two categories. On paper, a cryptographic representation of a conventional asset allows parties to derive the benefits of digital and blockchain technology as a means of transferring value, without having to take a punt on an entirely unbacked asset. This is at the core of Facebook's offering with Libra.
Stablecoins also reduce friction in the trading of cryptocurrencies. Crypto exchanges can now offer currency pairs between stablecoins (such as USDC (US Dollar Coin)) and cryptocurrencies (such as bitcoin) without having to interact with the conventional financial system or handle fiat currency (and the associated regulation). Similarly, when traders wish to exit positions in cryptocurrencies, they can park their crypto assets in stablecoins without converting back to fiat currency (avoiding the inefficiency and potential tax liability in doing so).
Ultimately though, a stablecoin is only as valuable as the trust that can be placed in the party issuing it. Trust that: (a) the issuer has effective mechanisms for keeping the stablecoin pegged to its underlying assets - not always an easy task - the label 'stablecoin' is aspirational, not descriptive; and (b) trust in the issuer's ability to honour requests to redeem the stablecoin for its linked asset or currency.
The requirement for trust is of course a departure from the founding ideals of the blockchain. In many ways, far from a new development, stablecoins, where representative of a fiat currency end up looking a lot like e-money - a concept that has been regulated in Europe for nearly a decade. This was a observed by Simon Scorer, Senior Fintech Specialist at the Bank of England, speaking at Money2020 this month.
For the time being, stablecoins feel like an interim step on a road towards greater digital representation of assets. A bridge between the conventional and the cryptographic. Our ultimate destination may be the widespread adoption of cryptocurrencies, or perhaps more likely, the digital issuance of fiat currencies by central banks. Whichever the destination, the rise of stablecoins over the last 12 months and the introduction of Libra by Facebook is likely to add to pressure on policymakers and central banks to clarify the role of digital assets in the years to come.
